Although Moody’s expects the Slovenian economy to contract by 6.7% of GDP this year, they estimate that Slovenia will remain broadly intact beyond the current crisis.

Moody’s Investors Service has upgraded the Government of Slovenia’s long-term issuer and senior unsecured bond ratings to A3 from Baa1. Concurrently, the outlook has been changed to stable from positive.

The upgrade of Slovenia’s ratings reflects the following key drivers:

• The improvement of Slovenia’s debt burden and debt affordability metrics relative to peers; and Moody’s expectation that the debt reduction trend will resume next year as the economy recovers from the pandemic shock;

• The significant improvement of the health of the banking system, as well as the completion of the privatization of the country’s largest banks, since Moody’s previous upgrade of the sovereign rating;

The stable outlook reflects Moody’s expectation that the current crisis will not leave a significant and lasting negative impact on Slovenia’s economy and that the country’s economic and fiscal strength will remain aligned with the A3 rating. It also reflects Moody’s expectation that the banking system will remain broadly resilient to the pandemic shock, with the capacity to support the economic recovery next year. Conversely, the stable outlook captures the rating agency’s assumption that progress on key structural reforms, above all to the pensions system, will not materialize before the end of the current government’s mandate in 2022.

Regarding the first key driver mentioned above, Moody’s states that the most significant improvement to Slovenia’s fiscal metrics concerns the affordability of its debt burden, which has strengthened considerably relative to both rating peers and Moody’s previous expectations since their most recent upgrade of Slovenia’s sovereign rating in 2017.

The government’s interest payments to revenue ratio has decreased from 6.8% at the end of 2016 to 3.9% at the end of 2019, as Slovenia has benefitted from the low yield environment and the asset purchase programmes of the European Central Bank of these years to refinance relatively expensive maturing debt at much lower interest rates. Consequently, its interest payments to revenue ratio is now considerably stronger than the median of Baa1 rated peers and also stronger than the median of A3 rated sovereigns.

In the four years preceding the outbreak of the coronavirus, Slovenia recorded the fastest reduction of its government debt burden among any EU member state bar Ireland, with the debt-to-GDP ratio falling from a peak of 82.6% at the end of 2015 to 65.6% at the end of 2019. The economic impact of the outbreak of the pandemic will lead to a significant deterioration of Slovenia’s government fiscal balance and debt-to-GDP ratio this year, which Moody’s expects will reach -8.4% and 81.1% of GDP respectively. However, given the global nature of the impact of the coronavirus, most rating peers will see their fiscal metrics deteriorate by a similar magnitude. Hence, relative to peers, Moody’s expects that the significant improvements observed for Slovenia’s debt-to-GDP relative to Baa1 and A3 rated peers will remain broadly intact.

Although Moody’s expects the Slovenian economy to contract by 6.7% of GDP this year, the rating agency expects the economy’s growth potential, which the European Commission estimated at around 3% of GDP prior to the pandemic, will remain broadly intact beyond the current crisis. Although Slovenia’s tourism industry is somewhat larger than the EU average and will continue to suffer from weak external demand during the pandemic, the country retains a competitive and diversified goods export base in areas such as pharmaceuticals, automotive and electrical appliances which Moody’s expects will not be structurally weakened by the current crisis. Moreover, funding from the European Union’s Next Generation EU instrument will provide a boost to investment rates and growth potential over the medium term. Moody’s expects that a resumption of trend growth rates above the EU average will support the process of fiscal consolidation and debt reduction beyond the current crisis.

Regarding the second key driver mentioned above,  the agency states that since Moody’s upgrade of the sovereign rating to Baa1 in September 2017, the rating agency has continued to see significant and lasting improvements to the health and functioning of Slovenia’s banking system, which was the subject of a large-scale government recapitalization and nationalization programme as well as the transfer of non-performing assets to a bad bank at the end of 2013. At the time of Moody’s most recent upgrade of the sovereign rating, the average weighted Baseline Credit Assessment of Slovenia’s three main banks stood at “b1”. This has since improved by three notches to a score of “ba1” following a series of upgrades to the ratings of Slovenia’s main domestic banks.

These improvements above all reflect a significant reduction of non-performing loans (NPLs) in the Slovenian banking system, which were the key legacy of the country’s financial crisis. According to data from the European Banking Authority, the system-wide NPL ratio has declined from 13.3% in June 2017 to 3.5% in March 2020, following a series of loan repayments, NPL sales and write offs.

Meanwhile, the capitalization levels of the Slovenian banking system have remained above the EU average, although the excess capital in the country’s largest banks has been reduced owing to recent acquisitions.

The coronavirus crisis has also led to a deterioration of the banks’ operating environment. As a result, the banking sector’s profitability has declined owing to higher forward-looking loan loss provisions, while Moody’s expect that asset quality deterioration will only materialise into 2021, once the economic and employment consequences of the pandemic will become visible and the statutory loan moratorium ends. Based on Moody’s central scenario, the rated banks’ overall credit profiles should be resilient against the background of a deteriorating operating environment.

Factors that Could Lead to an Upgrade or Downgrade of the Ratings

Upward pressure could build on the rating if Moody’s were to see a reduction in debt levels beyond current expectations. Further improvements to the health of the banking system, as evidenced by further upgrades of the ratings of the main domestic banks, would also place further upward pressure on the rating. Tangible progress on reforms, above all to the pension system, that would materially reduce ageing-related fiscal risks and demonstrate the ability of Slovenia’s institutions to proactively tackle longer-term policy challenges would also be credit positive.

Negative pressure could build on the rating if the deterioration in key government fiscal metrics brought about by the coronavirus crisis would become more permanent, leading to a continued increase in the government debt burden. A resurgence of problems in the country’s banking sector or evidence that the current crisis would leave significant and lasting scars to the economy’s growth potential would similarly be credit negative.